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Smart Real Estate Investing Tips

Pro Tip: You can’t make money overpaying for real estate. Your goal should be to pay less than market value or don’t buy at all.

Even if you require 100% financing to purchase commercial real estate, as long as the price is significantly below market value, the banks will be easier to work with. Let’s say you find a piece of commercial real estate for 80 cents on the dollar, and you want to finance the entire purchase. The bank will think it’s helping you finance 80% when really they are financing the entire purchase. Some banks will only lend 65% of the market value, some less and some will lend more.

I needed a low priced warehouse to store materials for my construction company. I was paying roughly $900 a month to rent about 3,000 square feet at a secure and well-located property. I hated renting.

I began my search for a warehouse that was in the 10,000 to 15,000 square foot range within the City Of Philadelphia. I bid on many buildings with no luck. Although there was a lot of inventory, many of the warehouses were being bid on by condo developers who were willing to pay much more than I was.

I found a rare 13,000 square foot building near 59th & Market street in West Philadelphia. The neighborhood was a blighted area. Crime was very high and the area had been devastated by the Septa construction of the Market Street Elevated Train that went from a three year proposed project to about 16 years. Market Street was torn up for years. Protective fencing blocked the doors and stopped locals from buying at the neighborhood stores. The sidewalks and streets looked like a war zone. Piles of concrete, trash and blacktop were piled everywhere. The asking price for the warehouse started at $300,000 and three years later was down to $150,000. I offered $30,000 and settled for closer to $40,000. I believed that the eventual completion of construction of the train would bring transit-oriented development and other developers who would all help to improve the market value of properties in the neighborhood.

Since I was buying the warehouse for less than 50% of its market value, a local lender gave me 100% financing on a five-year amortization plus my closing costs. The payment was equal to the rent at the old warehouse I had rented.

After storing all my construction materials, scaffolding, and tools for about 17 years, I hired an architect to lay out potential floor plans for the warehouse and surrounding site. He came up with a plan for 24 residential units and one retail unit. I am presently exploring the feasibility of attempting to change the zoning to a six-story structure which would allow me by right to build 48 to 68 units plus one retail space.

Across the street, the City took an acre and a half of homes, lots, parking lots, and a cab company site through eminent domain. The Planning Commission has had concept drawings prepared by an architectural firm for a six-story structure that will probably cost in the $30,000,000 price range. As soon as a developer is chosen and work begins, my building should further increase in value. Presently, the warehouse and contiguous building lots are for sale in the $1,450,000 price range.

Since the building was paid off during the first five years of ownership and has no mortgage, I could sell the building and take back a large mortgage. That mortgage would act like a retirement annuity. For example, an $800,000 mortgage for 30 year amortization at 6% interest would be a $4,796 payment each month times 360 or total payments over thirty years of $1,726,560. Although it is rare for people to pay down a total 30 year loan, you understand the potential math.

I am still not sure if it makes more economic sense to sell or develop. We are about two miles to Penn and Drexel. Our local City Council person is pro economic development. I will probably continue to market the property for sale while I press on to seek better zoning which will positively affect the property value.

Later this week I will be meeting with a local hedge fund operator who I have helped with two of his families real estate transactions to explore starting up a real estate fund that would be set up to fund well-priced or underpriced real estate that would be held as rentals, rehabs and resales or to immediately wholesale. We may also explore setting up a real estate fund to build the 48 to 68 units if the zoning is approved. It would create instant financing for the project.

My next blog will discuss the decision to purchase a shore home in Ocean City, NJ that needed almost total renovation as a way to save for three college tuitions when our children were 3, 4 and 5. It took 40 written offers to get a great deal. If you purchase a very affordable investment property in an area that appears to be in the path of future development when your child is three years old, you purchase wisely, use sweat to build equity, rent out the home for 15 years, sell when the child is 18 for college tuition you can save for college easily. Sure and slow. Three kids may require three houses. This was the reason we purchased our shore home. Thanks for visiting our website.

Doubling Your Home Size

My wife and I returned from Denver with our two babies and a third on the way. Our home in Philadelphia had been rented while we were away. We wanted to renovate and add on more space for our growing family. I also wanted to develop a workspace where I could work from home that would be separate from the family space.

I called my old friend Bob Thomas, who was one of the two founders of Campbell Thomas & Company in Philadelphia. Bob was an environmentalist who rode his bike everywhere in all kinds of weather, He had been a Peace Corps volunteer in Micronesia who did not believe in wasting and was a hardcore recycle advocate. He and his partner developed most of the Fairmount Bike paths in Philadelphia as volunteers when they first opened up their architectural firm. They started their humble firm and gradually grew it to a nice sized company that is still going strong today.

Unforeseeable Issues

Bob designed plans that my wife and I both liked. We went to our banker and applied for a construction loan. Our tenant moved out the day we began demolition. We soon ran into many unforeseeable issues like carpenter ants in some of the walls and part of the roof. A structural wall that held up the house and carport was in early failure. We hit rock when excavating for the rear addition. We were forced to remove all the first floor exterior walls and temporarily support the entire roof structure. All could be repaired or replaced but not within our original budget.

We headed back to the bank to increase the size of the loan. Due to unforeseen issues and other changes, our original $150,000 construction budget was now almost $300,000. As work progressed, we decided to replace 90% of the plumbing, 100% of the electrical, and the large heating system was now redesigned and replaced with three heating and cooling zones so we could shut down the parts of the house that were not in use. Construction was booming back in the late eighties and getting good construction labor was tough. We hired two of the guys who worked for us in Denver, flew them here and they lived in the last room of the house that we had not yet gutted.

The job took about a year. We had to visit the bank for another bite at the construction financing apple and we were approved but the lender said don’t come back. This is the last increase that they would allow. We finished the construction and moved in. The home was purchased in 1980 for $130,000. We put in another $450,000 and had a home worth about $780,000. I earned about $200,000 in equity for the year since I did not draw down a paycheck. My wife was working full time and we were able to live off her income. If I took the $200,000 as salary we would have lost about $90,000 to federal, state and social security taxes because the taxed owed would have been at the highest tax bracket. By not taking a salary and leaving the equity in the house we would have $200,000 in new equity to borrow against if we came up with another healthy real estate investment. Talk to your accountant if that does not make any sense to you or to understand. You don’t pay income tax on borrowed money, only earned money.

Financial Benefits

Each of my children required an educational environment not offered in our public school system. The equity built up from renovating our home paid for many years of private school, uninsured medical issues, and other real estate investments. As the years went by and our home kept growing in value, we applied for a $250,000 line of credit for our children’s education and as a slush fund for investments. It also funded a construction company, roofing company, and a 13,000 square foot warehouse for storage for the construction company.

Pro Tip: If you purchase large or small real estate investments and you are able to perform some of the work, even part time, you end up with equity, or what I like to call forced savings.

These forced savings do not require you to pay income tax until you sell the property. For example, if you purchase a rental for $100,000, you put in $50,000 in improvements and you put in sweat equity by performing all the demolition, insulation, some of the drywall, all the painting and landscaping, and you save an additional $25,000 in labor, then if an appraisal shows that the new market value of the home is $225,000 and you only owe $150,000 in debt, your equity is $75,000. Most banks will allow you to borrow up to 90% of the market value of your home if you have acceptable credit. If you needed the $25,000 to live on, you would pay federal and state taxes at your rate and social security tax of around 7% of the $25,000 which would be around $8,500. You would take home about $16,500 net. If instead you borrowed against that same $25,000 equity and the bank said we will give you a 90% mortgage against your $25,000 equity they would lend you $22,500 for your next investment. It is kind of like borrowing your way to wealth.

Investing in Denver Real Estate

In 1983, the economy in Denver, Colorado was in great shape. By 1987 the only people making money was UHaul. Everyone was leaving. The economy had tanked.

Investing in Denver

In 1984 we went to the Municipal Credit Union and opened an account because my wife was a city employee at Denver General Hospital. They had a unique program where you could borrow $125,000 minimum for a home purchase. We found a home that needed work, was well located, and could be purchased for around $100,000. We purchased the home with our 12% interest mortgage and immediately started looking for another investment property to spend the balance of the $125,000 mortgage.

We found two homes that were moved by a developer to two lots he had purchased. He got the homes for next to nothing because they had to be moved immediately from a site where another developer was building new homes. Back then you could buy an FHA financed home and assume the mortgage for only $45. My wife and I purchased two homes, next door to each other for $58,000 each plus closing costs. We only needed an approximate total of $2,800 to purchase both homes and assume the two existing mortgages. These were non-recourse loans. That means if we walked away from the homes, stopped payments and left the country, all the lender could do was foreclose and if there was a shortfall the original borrower, not us, may or may not have had to come up with the difference owed the bank.

I started a new construction company and within one week I had my first contract. My wife and I would walk at night in one of the wealthiest neighborhoods, Cherry Creek, place attractive flyers in mailboxes, and the phone started to ring. We were both working full-time and investing in real estate.

We now had three homes in Denver and it was time to look for another project. I found an abandoned looking building at the corner of 34th and Williams, in Denver. After months of negotiating with the minister who owned the building, we agreed on an $85,000 purchase price. It had 28 units. We were able to get an FHA 221 D4 mortgage which is an FHA insured mortgage for buildings with more than four units and we were able to borrow an additional $85,000 from the City of Denver for zero percent interest, no payments for 10 years, and an $80,000 mortgage at 2% interest with no payments for three years. We also received an $8,500 grant for new concrete paving. The City required us to build only two bedroom units in return for the low interest and creative financing we were offered.

To purchase the building, the United Bank of Denver wanted a co-signor. I was still new to Denver without much of a local track record so I went out and found another investor. It cost me half the ownership but made doing the development possible. My new partner and his wife, along with myself and my wife all had to be on the deed and on all the loans. The bank and City now had four co-signors.

We closed on the building, and went through the very tedious mortgage application process with the lender and the City. We began demolition and removed about thirty dumpsters of material from the building including the demolition of about 10 garages. We were told that the police and fireman would no longer go into the building if it had interior hallways, because it was too dangerous. They required every unit to have its’ own exterior entrance door. Police and fireman had previously been hurt inside the building going after drug dealers, putting out fires and lawbreakers in the building. We had to put an iron grate above the stairway that led to the basement laundry so that tenants could look down and make sure no one was lurking before they went down the steps to the laundry. The stairwell had to have a shatterproof light that was hard to destroy. We had to build a second floor rear deck with ingress and egress steps for the second floor tenants. In return we were promised section 8 certificates for all the tenants the first year only. We agreed to the terms. The architect completed the drawings, the City accepted them and with a very tight budget we began to rebuild the building.

The loans required the City, the architect, and an FHA inspector to approve each of the draws to be reimbursed after each segment of the work was completed. The City and FHA inspector was easy to deal with but our architect was always fighting us on the amount of work completed. He was paid about $28,000 over the course of the design and project phase of the contract and became one of the biggest problems to overcome on the project.

From an economic point of view, developers were entitled to depreciate the entire construction cost over a five-year period for affordable housing during the time we developed this building. For example, if the construction cost of improvements to the property was $1,000,000, you could deduct a tax write off of $200,000 each year for five years. Since I had a partner, we could each write off $100,000 each year for five years. If you had a total of $100,000 in income and you had a $100,000 write off then you owed zero taxes that year. There are many other factors but in its most simple form that is how the accelerated depreciation worked.

Issues on Site

About one-third of the way through the job, we started having petty burglaries on the site. Twice the office was broken into and twice the burglar stole battery-powered drills but both times left the batteries and chargers. They don’t work very well without batteries. Then we decided to add security dogs to the site. The second night we had the dogs, a neighbor walked over to the site and said those dogs would run away if he jumped over the fence. My foreman wagered his truck that the dogs would attack the man if he jumped over the fence as he waggled his keys at the neighbor. The neighbor agreed to the wager, leapt over the fence and the two dogs ran away. The man comes back asking for the truck keys. The neighbor was a security dog trainer who knew that until the dogs marked the site and were delivered to the site enough times to become habituated to the site that they would not protect the site.

About two weeks later someone went over the fence and was attacked by one or both of the dogs and left a trail of blood. Just another day at the site. Each morning the dog service removed the dogs from the site. Two dog security companies bid on the contract, one was $10 a day for two dogs and the second company was $20 a day. I asked why the big difference? The $10 an hour company said that they have no insurance and no assets. If someone gets hurt by the dogs after breaking in and sues, the first thing the lawyer wants to know is who the insurance carrier is? If no insurance most lawyers are not interested in the law suit unless the client can pay up front. Most burglars don’t have the money to fund a lawsuit. We were on a budget. We went with the $10 guy.

FHA Requirements

When you have an FHA mortgage and you borrow public funds from the city, state, or federal government, you are required to develop a plan to have a minimum amount of minority and female participation employees and contractors. My philosophy has always been to hire locals on a job site when they are available because I believe local neighbors should benefit from projects in their own communities. I have also been a proponent of hiring ex-offenders who have served their time, need a break and tend to be hard working individuals when hired. We had two laborers I hired who were two of the biggest guys you could ever find. One served nine years for murder and the second served time for unknown crimes. I had a subcontractor who was third degree black belt in one of the martial arts who had just returned from Vietnam. I had a young woman who was a carpenter who lived in the neighborhood all her life. We had almost 65% minority and female owned company participation on the job.

The job took about two months longer than I figured. The inspections were not always easy to schedule. I was able to rent out all ten units quickly. The federal government always sent the section 8 checks on time. My wife took a new job back in Philadelphia and wanted me home. Workers tend to slow down a bit when a job ends and unemployment is near. I was about $20,000 over original budget but still within the 15% required in the mortgage for contingencies. All went well for the first year.

After final inspections are complete, you receive your certificate of occupancy from the city, tenants move in, and the rents begin to arrive. You can finally begin to relax. For the first year, the building thrived.

The Denver economy was crashing. The oil industry was in turmoil. Companies were walking away from their wells and their equipment. Many were moving away from Denver. Tenants could go to the most beautiful buildings in town and get cheap rent. Section 8 tenants were moving to the expensive sections of town because building owners who never accepted section 8 were now accepting the certificates. Many of the small developers like us who were located in the higher crime areas of Denver were unable to rent their units. The population was dropping rapidly. It was a mistake to move forward with only one year of section 8 certificate guarantees for such a large project. We should have held out for at least three years or walked away from the project, but no one has a crystal ball.

Almost Anyone Can Be a Successful Real Estate Investor

I purchased my first piece of real estate with almost 100% financing back in 1978. I was 27 years old. It was a beat up triplex with central heat and electric. The price for the three units was $8,500. It was located in a then-blighted area of South Philadelphia. It was close to the school where I taught so it was easy to work on the building for a few hours each day after classes.

Early Mistakes

After settlement I went to the home and wondered what part of crazy I was listening to when I agreed to purchase this house. The real estate agent told me that we could access two of the units but the second floor tenant would not give us access. I purchased the home anyway without any inspections and began my days as a landlord.

At the time, I was a full-time woodworking and construction technology teacher. I thought that I could do all my own repairs at cost and that my first venture into real estate investment would be a quick success. Not so.

Pro Tip: Separate Metered Utilities are Key

My first piece of advice to you is never buy real estate where the tenant does not have metered utilities. You only want properties where utilities are separate or be ready, willing and able to install them immediately after settlement before you begin renting the property.

Lessons of a New Landlord

One of my wood shop students came to class saying that his family was looking for an apartment. I met his mom and she agreed to the terms of an acceptable lease and moved in. The landlord paid for heat and electricity.

Pro Tip: Always Investigate Potential Tenants

I did not do any background checking, no credit report, nothing but blind faith that they would move in and be a happy tenant in my triplex.

They did not pay the second or third months’ rent and would call and say the oil had run out. It was on an automatic oil delivery. I had three tenants and only one was paying on time. Within a week of another oil delivery, I got a call that the oil had run out again. I went to the home and knocked on the door of the first floor unit where the thermostat was, and found the unit to be 85 degrees inside. The unit with the thermostat for the entire building was located near a window the tenants had broken and they did not attempt to even cover the window with cardboard or call me to make a repair. They simply turned up the thermostat. The second and third floor units had their windows open because the heat was too overwhelming on their floors. I was spending more on oil than the rents plus most of my teaching salary combined.

The first floor tenants had no interest in paying the rent nor did the inherited second floor tenant. The third floor tenant paid on time but her entire rent check was spent on my oil bill.

I soon found out that taking tenants to court for non-payment and eviction was a 9 month process back then. I was on the verge of bankruptcy with my new real estate investment. I replaced the broken window glass but the financial damage was done. Too many oil deliveries, I had been heating the outside, too little rent, and not enough teacher income to overcome the monthly overhead.

I told the paying tenant that she should begin looking for another rental because there was no way I could continue to support this losing real estate investment anymore. I found out too late that first floor tenant had been evicted many times in the past and was a professional at mastering the art of free rental housing from rookies like me. I also had a conversation with the second floor tenant and he agreed to move voluntarily when I told him the facts about my situation.

A Little Bit of Luck

Then divine intervention occurred. I ordered another load of oil and before they could deliver it a debilitating snow storm hit South Philly. None of the small streets could be plowed. It took at least seven days for my street to become passable for an oil truck. The oil in the triplex ran out on the first day of the storm. Three days later, a radiator froze and flooded the first floor. When the first floor tenant called I suggested she use the back rent she owed me to find another place since the unit was no longer fit for a tenant and repairs could take months.

Within five days of the storm all the tenants had moved out. The water was turned off. No more oil required. I hired an architect to help me redesign the entire building with separate utilities. I began to demo the interior of the building over the next year and set up the first floor with a small wood shop. I had a small construction company with another teacher friend and we used the triplex for material storage and as a base of operations for the next few years.

City Squabbles

In the summer of 1983, I married my wife and we moved to Denver, Colorado. We stayed for almost four years.

Before I left for Denver I purchased new windows for the third floor of the triplex. We gutted the third floor, reframed for the new windows and when I realized we were moving to Denver I stored the windows at the triplex and closed up the newly framed window openings on the third floor with plywood. At that time, the city of Philadelphia was boarding up vacant homes trying to stop drug dealers who were squatting and dealing in anything vacant.

My home was maintained by a local subcontractor I worked with and who lived down the street. He called one sunny day and said that the city had ripped out the first floor windows, doors, my marble lentils over the windows and doors and removed my marble steps. $20,000 worth of tools, equipment, scaffolding and materials were removed from the property.

I never received any notice, only a $1,700 bill for the close up work performed. Years later, I went to a hearing and the judge threw out the bill but said that all the materials and tools removed from the building were a loss to me because you have to sue the city within 6 months of this type of wrongful event or the statute of limitations runs out.

Because the city removed the supporting lintels above the doors and windows and placed the cinder block at the front door on top of the interior flooring instead of the foundation wall, the building began to sag and fail. The cost to remediate was way above the value of the building. Eventually, the city took down my triplex and the triplex next door. I now had a vacant lot.

I received a bill from the city for about $12,000 for the demo and then another bill for thousands more for stucco they claimed to put on the attached neighbor’s home when they took my triplex down. Since they took both buildings down together, the city tried to charge me not only for the demo that they caused but for work on stucco never performed.

The city contacted me for a hearing regarding the two bills and I arrived with my young daughter. I wanted her to experience first hand the trials and tribulations of owning investment property. Eventually the judge agreed that the city caused the problems leading to the required demolition and agreed that the stucco work had never been performed. The judge was a reasonable man and sought a compromise. I agreed that if I tore down the building at cost it was take approximately $2,000 for labor and dumpsters to take down the building. He asked for $2,400. I agreed if they would take $100 a month for 24 months with no interest and he agreed.

I paid off the $2,400 and kept the vacant lot well maintained and allowed a community gardener to grow fruit and vegetables at no cost in return for keeping the lot clean.

When the city contracted out the demolition they had huge heavy equipment with steel tracks that damaged the concrete walkway. The city was unresponsive about replacing the concrete. They started sending threats of lawsuits if I did not replace the concrete. I would respond politely asking them to replace the concrete that they destroyed during demolition. A stalemate occurred and they left me alone.

Long Term Success

During 2016, finally, the South Philly real estate market was on fire. It was time to sell my vacant lot. Purchased in 1978 for $8,500 and I sold it in 2016 for $60,500. I held onto that property for thirty-eight years. My first investment property was like a masters degree in what NOT to do in real estate investing. Although the ownership included a lot of grief, aggravation and stress, I wish now that I had purchased 100 of those properties, but only those with separate utilities. 100 of those paid off vacant lots today would be worth somewhere around $6,500,000 today.